Dual Entity Salary & Bonus Processing with Tax Slab AdjustmentBy Rajendra Prasad Sappa, Chief Delivery Officer, AscentHR

Objective

The objective of this concept note is to address the scenario where employees of a company (Entity A) receive their salaries processed by one entity, but their bonuses are processed separately by another entity (Entity B). The goal is to ensure that tax obligations are correctly applied, accounting for both salary and bonus income, even though Entity A does not have direct visibility into the bonus amounts processed by Entity B. The system needs to adjust the tax rate for the salary income based on the combined value of the salary and bonus, while still being compliant with tax laws.

Background

In some organizational setups, compensation is structured in such a way that base salaries are processed and paid by one entity (Entity A), while performance bonuses or incentive payments or ESOP’s are handled by a separate entity (Entity B). This situation can present a challenge when it comes to taxation, as the total taxable income (which includes both salary and bonus) determines the applicable tax slab. However, because Entity A does not have access to the bonus details from Entity B, it needs a method of applying the correct tax rate based on total income (salary + bonus).

Approach

1. Income Structure:

• Entity A: This entity processes and pays the employee’s salary, which is subject to income tax based on salary slabs.
• Entity B: This entity processes and pays the employee’s bonus, which is also taxable. The bonus is typically paid separately due to business requirements, and Entity B handles the withholding tax on this bonus.

2. Tax Calculation Method:

• Both salary and bonus are treated as part of the employee’s total income. To ensure correct tax application, Entity A must apply tax slabs as if it had access to the bonus amount.
• Entity B will be provided the Taxable Income of the employees that needs to be factored to arrive at the revised Taxable income (including Bonus) in Entity B. Such data will be reported temporarily under Previous Employment Income tab for arriving at the right tax liability after netting off the taxes that would be referred in Entity A.
• Since Entity A does not know the exact bonus amount, Entity B will notify Entity A of the applicable tax rate on the bonus that was withheld. This rate will be factored by Entity A will then use to adjust the salary tax rate.

If such bonus is processed during the year (not at the end of the financial year), the exercise will have to be repeated for such employees if there is a change in the Taxable Income of Entity A.

3. Tax Slab Adjustment:

• Once Entity A receives the applicable tax rate for the bonus from Entity B, it will apply this rate to revise the tax on the salary.
• The tax rate provided by Entity B reflects the combined salary and bonus income, ensuring that the employee’s overall tax liability is aligned with the total taxable income.
• Based on this information, Entity A can adjust the tax rates applicable to salary income by applying the rate that would have been applied if the salary and bonus were considered together.

If such bonus is processed during the year (not at the end of the financial year), the exercise will have to be repeated for such employees if there is a change in the Taxable Income of Entity A.

4. Communication Between Entities:

• Entity B to Entity A: Entity B will communicate the applicable tax rates for the bonus, typically after bonus disbursement and tax deduction.
• Entity A Adjustment: Entity A will receive the communicated tax rate and adjust the tax rates on the salary. This process ensures that the tax differential between the two components (salary and bonus) is accounted for correctly.

5. Challenges and Considerations:

• Communication Delays: Timely communication between Entity B and Entity A is critical for ensuring that the tax slabs are adjusted on time.
• Accuracy of Bonus Tax Rate: The tax rate shared by Entity B must accurately reflect the combined income to ensure that the final tax deduction is correct.
• Legal Compliance: Both entities must ensure that they comply with local tax laws (E-TDS Quarterly and annual Filings as well as issuance of Form 16) regarding withholding tax, bonuses, and salary taxation.

Conclusion

This dual-entity salary and bonus processing model ensures that employees are taxed based on their total income (salary + bonus) while allowing each entity to handle its respective role in salary and bonus processing. By adjusting the tax slabs for salary based on the bonus income, the system ensures that employees are taxed in a way that accurately reflects their combined earnings, without over- or under-taxation. Proper communication and data sharing between entities are essential for the smooth functioning of this model.